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Better Buy: Intuitive Surgical, Inc. vs. Johnson & Johnson

Which of these healthcare leaders is the best choice for your portfolio?

With multiple catalysts likely to fuel its growth, the healthcare sector is fertile ground from which investors can reap sizable profits -- if you know where to look.

To help you in this regard, we're pitting two outstanding healthcare businesses -- Intuitive Surgical(NASDAQ:ISRG) and Johnson & Johnson(NYSE:JNJ) -- against each other to see which is the best buy today. Let's see which of these stocks is the best place for your investment dollars.

Image source: Getty Images.

Moat

Intuitive Surgical dominates the robotic surgery market. Its da Vinci surgical system has faced little competition since its introduction in 1999. And while new competitors are beginning to enter this valuable arena, Intuitive holds a commanding lead built upon its massive installed base of more than 4,000 da Vinci machines currently in use around the world. Surgeons have performed over 4 million procedures to date on da Vinci systems, logging countless hours on them in the process. This helps to strengthen Intuitive's economic moat by increasing its customers' switching costs. The large amount of time and capital doctors and hospitals have already spent to become proficient with these robotic systems makes it difficult for them to switch to a competing product.

Johnson & Johnson's competitive advantage resides in its massive scale, diverse revenue streams, and leading positions in multiple important markets. J&J is a global leader in pharmaceuticals, medical devices, consumer healthcare, and biotechnology, among other areas. Moreover, it reinvests a substantial portion of its massive cash flow every year into research and development, so as to constantly strengthen and expand its leadership position in these industries. It's a virtuous cycle that has benefited shareholders for decades, and that should continue to do so for decades to come.

Both of these businesses possess powerful competitive advantages. But while formidable rivals could pose a potential threat to Intuitive Surgical, it's more difficult to imagine a situation where Johnson & Johnson is unseated from its throne atop the healthcare sector. Thus, I'd argue that J&J has the wider moat.

Advantage: Johnson & Johnson

Financial fortitude

Let's now take a look at some key metrics to see how Intuitive Surgical and Johnson & Johnson stack up in regards to financial strength.

Metric

Intuitive Surgical

Johnson & Johnson

Revenue

$3 billion

$72.5 billion

EBITDA

$1.1 billion

$24.8 billion

Net income

$0.9 billion

$16.3 billion

Operating cash flow

$1.1 billion

$20.7 billion

Free cash flow

$0.9 billion

$17.6 billion

Cash & investments

$3.8 billion

$12.9 billion

Debt

N/A

$34.6 billion

DATA SOURCE: MORNINGSTAR.

Intuitive Surgical has a pristine balance sheet with more than $3.8 billion in cash and investments and zero debt. It's also a highly profitable business, with a net profit margin of approximately 30%, which in turn helps fuel its impressive free cash flow generation.

That said, Johnson & Johnson is a financial titan. Even after adjusting for its sizable dividend payout, J&J generates nearly 10 times as much free cash flow as Intuitive does on an annual basis. This -- combined with its diverse revenue streams and bountiful cash reserves -- has earned Johnson & Johnson a triple-A rating from the major credit rating agencies, making it one of only two U.S. companies that can claim that distinction (Microsoft is the other). As such, Johnson & Johnson has the edge in terms of financial fortitude.

Advantage: Johnson & Johnson

Growth

Over the past decade, Intuitive's revenue and earnings growth have far exceeded that of Johnson & Johnson.

Yet over the next five years, Wall Street expects these companies to grow their EPS at surprisingly similar rates: 10.23% for Intuitive and 6.97% for J&J. So Intuitive still comes out ahead, but it's much closer than I expected.

Advantage: Intuitive Surgical

Valuation

No better-buy discussion should take place without a look at valuation. Let's check out some key value metrics for Intuitive and J&J, including price-to-sales, price-to-earnings, and price-to-free-cash-flow ratios.

Metric

Intuitive Surgical

Johnson & Johnson

P/S

14.56

5.40

Trailing P/E

48.21

23.99

Forward P/E

39.53

18.35

P/FCF

45.52

21.60

DATA SOURCES: MORNINGSTAR.

On all four metrics, Johnson & Johnson's shares are far less expensive than Intuitive Surgical's. Even if we factor in Intuitive's higher expected earnings growth rate over the next five years, it's price-to-earnings-to-growth ratio of 4.17 is still well above J&J's PEG of 2.79. All of these metrics are therefore suggesting the same thing: J&J's stock is currently the better bargain.

Advantage: Johnson & Johnson

The better buy is...

Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Joe Tenebruso has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Intuitive Surgical and Johnson & Johnson. The Motley Fool has a disclosure policy.

Author

Joe honed his investing skills as an analyst for Stock Advisor, Fool One, Supernova, Million Dollar Portfolio, and Income Investor. He battle-tested his investment philosophy and strategies as portfolio manager of Tier 1, a market-crushing Motley Fool real-money portfolio that delivered 24.58% annualized returns during its existence. Now, Joe’s mission is to pass on what he’s learned -- and what he continues to learn -- as a contributing writer to Fool.com.
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